Okay, here’s a breakdown of the key points from the provided text, focusing on the history and implications of the Collins Amendment and its interaction with subsequent regulatory changes:
1. The Original Problem & The Collins Amendment’s Intent:
* Dodd-Frank Act: Introduced two major changes: capital requirements for operational risk/CVAs and allowed US banks to use internal models for capital calculation.
* The Concern: Few banks outside the largest ones had the resources to build and maintain elegant internal models. These models generally result in lower capital requirements than standardized approaches. This created a risk that large banks would benefit from lower capital requirements, gaining an advantage.
* The Collins Amendment: Designed to prevent large banks from reducing their capital requirements or gaining an unfair advantage. It mandated that banks calculate capital using two methods:
* Advanced Approach: Included new risk types (CVA, operational risk) and allowed internal models.
* Collins Floor: Used the older, standardized approach (credit & market risk only).
* Banks had to comply with the higher of the two calculations.
2. The unintended Result: The Collins Floor Became Binding
* Within 5 years: The Collins Floor became the primary constraint on capital for most large banks. It wasn’t the intended outcome, but it happened.
* Stress Capital Buffer (SCB): the introduction of the SCB in 2020 reinforced the Collins Floor’s dominance.The SCB is a dynamic buffer based on stress test results, and it’s generally much higher than the previous 2.5% capital conservation buffer. This meant the Collins Floor was even further above the advanced approach.
3. The Irony & Current Situation: Basel III & Lobbying
* Basel III Looming: As Basel III implementation approached, rumors surfaced that US regulators might eliminate the internal ratings-based (IRB) approach for credit risk. This would mean all banks would have to use standardized approaches for credit risk.
* Industry Response (Lobbying): Banks, especially those with large SCBs, lobbied to preserve the dual-stack (Collins Floor + Advanced Approach) even if internal models were removed for credit risk.
* The Logic: These banks reasoned that their large SCBs would still make the advanced approach (even without IRB) lower than the Collins Floor. Thus, eliminating IRB wouldn’t actually change their binding capital constraint. They wanted to avoid any changes that might increase their capital requirements.
* A Critique: The initial quote suggests that the dual-requirement structure wasn’t based on sound calibration but was a way to “reverse-engineer higher and higher capital aggregates.”
In essence, the Collins Amendment, intended to prevent a reduction in capital, ended up increasing it for large banks. Now, those banks are trying to maintain the system, even though the original justification for it is fading, because it’s become advantageous to them due to the SCB.
Let me know if you’d like me to elaborate on any specific aspect or analyze the implications further!